Unemployment and Wage Growth in US – No sharp pickup in wage growth foreseen by FRBSF

The unemployment rate ended 2018 at just under 4%, substantially lower than most estimates of the natural rate. Could such an ostensibly tight labor market lead to a sharp pickup in wage growth from its recent moderate pace, such that the relationship between wage growth and unemployment is not always linear? Investigations using state-level data show no economically significant nonlinearity between wage growth and unemployment that would predict an abrupt jump in wage growth.

By most measures, the U.S. labor market is currently quite strong, with several industries even experiencing labor shortages. The U.S. unemployment rate has steadily declined since the end of the Great Recession and ran below 4% in the second half of 2018. Many forecasters expect unemployment to fall further, even after factoring in the recent volatility in the financial markets and declines in stock prices. The median projection from the Federal Reserve’s Summary of Economic Projections (SEP) sees the unemployment rate hitting 3.5% by the end of 2019, a level not seen since 1969. Other labor market indicators, from broader measures of unemployment to job quit rates or the rate of job vacancy postings, have also been strong and point to a tight labor market. Strong demand for workers in a tight labor market should push up wages. Yet, while wage growth has increased since the end of the Great Recession, the increase has been surprisingly modest relative to the pace of labor market tightening.

A careful look at the wage Phillips curve across states yields little evidence supporting the contention that wage growth sharply rises as the labor market reaches especially tight conditions. Of course, the current period may be different from the past. For instance, the typical pattern of local wage growth in a tight local labor market may differ when all other nearby labor markets are experiencing similar tightness, as is currently the case. As a result, geographical labor mobility—which can mute wage pressures in tight markets as workers are attracted to higher-wage areas—may be playing less of a restraining role. With this caveat in mind, given the historical experiences of states in recent decades, we do not foresee a sharp pickup in wage growth nationally if the labor market continues to tighten as many anticipate.